The sentiment in the bond market is likely to remain weak in the run up to central bank’s monetary policy on February 6-7. With the government missing the FY18 fiscal deficit target, the yields on government bonds have continued their hardening trend seen over the recent weeks.

The RBI on Friday once again cancelled its scheduled auction of dated securities, signalling its discomfort with yields. This is the third time since December 29 that the central bank has cancelled, either fully or partly, an auction making it clear that a sudden spike in yields was the reason for not accepting any bids that bidders would have placed with the central bank. With the three auctions cancelled, the total stock not sold yet amounts to Rs 26,000 crore.

On Thursday, there was a virtual blood bath in the bond market, but it marginally improved on Friday. The benchmark sovereign (10-year government security) closed at a yield of 7.80 per cent (on Thursday), which was nearly 140 basis points higher than its August 2017 levels. The trend improved a bit with the old tenor benchmark closing at 7.75 on Friday.

Traders said rumours that the Reserve Bank of India (RBI) may do open market operations (OMO) purchase of bonds to cool the yields and speculation that there will be a relaxation in foreign portfolio investment limits in government bonds were the key reasons for the mayhem in the bond market. Banks have stopped buying government bonds as they hold excess bonds in Statutory Liquidity Ratio (SLR) portfolio.

The banking system holds about 9-10 per cent excess SLR securities (government bonds) and will be forced to provide for the mark to market depreciation, if yield levels do not improve by this quarter end.

Ashutosh Khajuria, executive director at Federal Bank, told FC, “There may be hardening of yields this week but in the medium term yields will fall. If the RBI continues with its earlier neutral stance and there is no hawkishness in its statement then there will be a big rally in the bond market and yields may cool by 30-40 basis points. The old tenor benchmark can fall to 7.35 per cent while the new benchmark would fall to 7.15 per cent.”

In addition if the oil prices improve and there is no weather shock to the Rabi crop then I think the inflationary pressure may be lower and if this is described in the RBI’s policy document then the unnatural spread between the 10-year benchmark over the policy repo rate will correct to 30-40 basis points, he added

The spread of 10-year sovereign over the policy signalling rate (repo rate at 6 per cent) has increased to 175 basis points which in a neutral policy stance has historically remained in the band of 50-75 basis points. One basis point is one hundredth of a percentage point.
From P1

A Bond yields and bond prices move in opposite direction. Ajay Manglunia, executive vice-president and head of fixed income advisory at Edelweiss Financial Services, said, “There were a couple of rumours that caused a mayhem in the bond market. One, that the RBI may do some OMO purchase to arrest the rising yields, then there was speculation that there will be a relaxation in foreign portfolio investment limits in government bonds. But these reports turned out to be false as there was no auction during the day. This kind of volatility was not even seen on 9/11 when the US saw terrorist attacks.”

“Bond markets reacted very negatively to the budget announcement. We expect sentiment in rates markets to remain weak in the near term,” said Nomura India.